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Bill Clinton’s January 19th State of the Union Address did much to make Americans more comfortable with the notion that Social Security’s future is dependent upon investing some portion of it in real assets, not paper IOUs, and that workers must be given a choice in how their retirement dollars are to be invested. While these are two sound ideas, he unfortunately came short of fully embracing them. Perhaps out of political necessity, Clinton bowed to his political left by splitting private investment and personal savings accounts apart, opting for a big-government approach to both of these concepts.

Since the liberal elite is ideologically opposed to allowing individuals to divert a portion of their Social Security taxes into personal retirement accounts, Clinton opted for a proposal that would have government officials invest a portion of the budget surplus in the stock market in order to shore up the system’s finances. This idea – a non-starter – is far too extreme in giving the federal government power over American business. The Clinton plan would also allow individuals to open "Universal Savings Accounts" (USA accounts), but only separately, and in addition to the taxes they currently pay into the system.

Overall, Clinton’s proposal largely continues the status quo and does nothing to change the fundamental flaws in the system. The implications of Clinton’s proposal are profound:

Social Security would remain a system reliant on debt and IOUs rather than a system built upon savings and investment;

Social Security would still become insolvent in 2013, spending more than it collects;

Social Security would remain a poor investment deal for future retirees – most will get far less back in benefits than they put into the system;

The government would gain unprecedented control over the capital markets;

The next generation of workers would be consigned to higher taxes to pay off the system’s staggering mountain of IOUs; and

Today’s taxpayers would continue to bear a historically high tax burden – 20.5 percent of gross domestic product (GDP) – for the next 15 years.

Perpetuating the cycle of debt. Clinton’s proposal would dedicate 60 percent, or roughly $2.7 trillion, of the government’s projected budget surpluses over the next 15 years to "save Social Security." Roughly 25 percent of this amount would be invested by an independent board in the stock market while the remainder would be "invested" back into the system by retiring other government debt. Clinton also calls for using an additional 11 percent of future surpluses, about $500 billion over 15 years, to allow low income individuals to open USA accounts that the government would then supplement with matching funds. Clinton claims that his plan would make Social Security "rock solid" without having to make "drastic cuts in benefits" or raising payroll tax rates – a statement that appears to leave the door open for small cuts in benefits or other means of raising revenues to close the funding gap.

What Clinton does not acknowledge is that his plan assumes that taxpayers will continue to send roughly 20.5 percent of GDP to Washington over the next 15 years in order to produce the $4.4 trillion in total budget surpluses projected by the administration. These budget surpluses are, by definition, a surplus of tax revenues – not a shortfall of spending – equal to every taxpaying household in America overpaying their taxes by $58,600 over the next 15 years.

A closer look at these proposals shows there is less to Clinton’s plan than is being claimed. First, Clinton's promise to dedicate 60 percent of surpluses to "save Social Security" is meaningless. These funds will not establish any kind of investment account that would grow in value for future retirees.

Instead, Washington would use these surplus tax dollars to buy down federal debt for a few years, only to run it up again by more than $8 trillion to pay the Baby Boomers' benefits through 2032. But no matter how much government debt Washington retires over the next 12 years, Social Security's costs will still begin to exceed its income in 2013, an event that will require lawmakers to cut benefits, raise taxes, increase borrowing, or some combination of all three.

Adding more IOUs to an empty trust fund. Because of Washington’s peculiar accounting practices, Clinton’s scheme will simply add $2.7 trillion in IOUs to Social Security’s paper "trust fund." These IOUs can be redeemed only by raising taxes on those Americans who are in the workforce after 2013. (Even if lawmakers cover the program’s shortfall with new borrowing, higher taxes will be required to pay down that debt.) The bottom line is that using surplus tax dollars to buy down federal debt creates no real assets in the trust fund that can be drawn down to pay future benefits. The process is simply an exchange of privately held debt for publicly held debt. This new debt is not an asset, but merely a claim to a portion of the government’s future stream of tax revenues.

To illustrate the illogic of Clinton’s debt financing scheme, consider a family in the process of deciding how to finance their 4-year-old’s college education. One option they have is to put $1,000 each year into an investment account, such as a mutual fund. If, for example, the fund earned 10 percent per year (7 percent after inflation) the family would have $35,000 in real wealth after 15 years. The other option they have is to put an additional $1,000 each year toward paying down their mortgage principal, with the idea that they would then take out a second mortgage when their child enters college. Both options will help finance the child’s education, but the first option creates real family wealth while the second option simply continues the spiral of family debt.

Having bureaucrats invest the surplus is a risky and dangerous solution for the wrong problem. The administration’s proposal to have bureaucrats invest a portion of the surplus ($50 billion to $60 billion per year) in the stock market would give the government and political system unprecedented leverage into capital markets. Taxpayers should question how the same government that fostered such debacles as the Savings and Loan bailout, the Mexican currency bailout, Jimmy Carter's Synfuels program, and proposed the Clinton health care program be trusted to "invest" our tax dollars wisely. Moreover, Federal Reserve Chairman Alan Greenspan has rightly pointed out that it would be nearly impossible to keep politics out of the investment decisions, no matter how lawmakers try to insulate an investment board.

Underlying this notion of having the government invest on Wall Street is the false premise that the Social Security system must get higher returns than what it now gets from "investing" in non-marketable Treasury bills, which typically "earn" about 5 percent. The administration argues that investing the same money in the stock market will bring a higher return and, thus, generate more cash for the ailing system.

One problem with this thinking is that since the non-marketable IOUs held in the Social Security trust fund are nothing more than a claim on future tax revenues, they do not generate an actual "return" on the bonds. In fact, lawmakers who now fret about the program’s low rate of return could at any time raise the interest rates on the IOUs, say to 10 percent, since these rates are largely set by a legal formula. The result of such an action, of course, would be an instant increase in the claim the Social Security system has on the taxes paid by future workers. On paper, the system would appear closer to actuarial balance, but it would be no closer to having any more real assets to draw down to pay benefits.

More importantly, even if government officials were able to increase the rate of return on the program’s "investment," Social Security will still be a bad deal for future retirees. Under current law, young workers today will receive far less back in Social Security benefits than they paid in FICA taxes. The goal of reforming the system should be to increase the rate of return for future retirees – thus improving their standard of living in retirement – not finding new revenue sources for the program itself. The only way lawmakers can increase workers’ rate of return is to allow them to divert a portion of their payroll taxes into personal retirement accounts that they, not the government, own and control.

Clinton’s Universal Savings Accounts are an add-on, not a carve-out. Clinton's proposed Universal Savings Accounts (USA accounts) will not increase workers’ rate of return from their FICA tax contributions because they are created in addition to the existing program, rather than being carved out of the program. The administration no doubt intends the USA accounts to curry favor with the numerous reformers who support Personal Retirement Accounts (PRAs), which are created by allowing workers to divert a portion of their Social Security taxes into private accounts.

But Clinton's USA accounts should not be compared to PRAs. USA accounts are, in effect, an encouraged savings plan on top of the 12.4 percent FICA taxes that workers already pay into Social Security. As it is, the current FICA tax rate actually collects $40 billion to $50 billion more revenue than what is needed to pay current benefits. Those who advocate PRAs would allow workers to divert at least 2 percentage points of their current FICA taxes (which would still maintain the system’s pay-as-you-go status) into private accounts that they control.

Clinton’s USA proposal should be rejected on two accounts: First, because the plan requires workers to continue to pay higher-than-necessary FICA taxes for the next 15 years; and, second, the proposal also assumes that taxpayers will willingly continue to send a record 20.5 percent of GDP in taxes to Washington for the next 15 years. Remember, the government’s first budget surplus in 30 years is largely the result of a healthy economy sending federal tax revenues soaring to their highest levels since World War II.

Audaciously, Clinton is assuming taxpayers will send $4.4 trillion more to Washington than it needs to run the government for the next 15 years so that he can use some of these surpluses (taxpayers’ own money) to allow them to open private retirement accounts and to "match" up to $400 in additional savings.

In other words, what Clinton is doing is keeping taxes too high so that he can give the illusion that the government is helping people save for their retirement because Social Security is such a raw deal. It begs the question: Wouldn't it make sense to just cut taxes across the board by at least 10 percent and allow Americans to figure out how to save for their own future?

Conclusion. To be sure, Clinton’s proposal has moved the debate forward by making Americans more comfortable with Social Security reforms that include private investment and personal accounts. However, his proposal neither fully embraces these concepts nor addresses the most fundamental flaws of the system, such as the fact that it is reliant on a mountain of IOUs, that it will become insolvent in about 12 years, and that future retirees will get less back in benefits than they paid into the system in taxes. But perhaps by breaking the ice on these issues, Clinton’s Social Security reform plan will lend political energy to other reform plans that directly address and solve these serious problems.